Mohnish Pabrai on Buffett's Investment Principles

Mohnish Pabrai emphasizes focusing on undervalued companies rather than those that are already overvalued. He advocates for a strategy that involves visiting foreign markets, such as Turkey, to identify businesses that are fundamentally strong but are being overlooked by the broader market due to geopolitical instability.

Pabrai states, "so what we are looking for is a business that is great but being overlooked."

Pabrai recounts a successful investment in a Turkish company that rents warehouses to major retailers like Amazon, IKEA, and Carrefour, making it the largest warehouse operator in Turkey. Despite the business having assets worth a billion dollars and only 200 million in debt, its market value was initially a mere 15 million dollars.

Mohnish Pabrai noted, "I met with on my second visit in 2019 is a company that rents warehouses through like Amazon, IKEA, Carour and they the largest uh warehouse operator in Turkey. The business had assets that were worth a billion dollars. there was 200 million of debt and the market value of the business was 15 million." This significant disparity led to the company's market value soaring to 1.8 billion dollars within seven years.

Pabrai references Nassim Taleb's analogy of a 'pie counter,' suggesting that investors will only encounter rare opportunities in their lifetime where all the best investment options are laid out. The advice is to wait patiently for these infrequent moments.

Mohnish Pabrai explained, "Talib said that few times, very very few times in our lives, we are going to get a trip to the pie counter where all the desserts are." When such an opportunity arises, investors should commit significantly and hold their positions for an extended period to maximize returns.

Pabrai draws parallels to the Nifty 50 index from the late 1960s and 1970s, an era when 50 large-cap stocks were considered unassailable. Despite their perceived strength, a market correction led to a dramatic 70% drop in these stocks, illustrating market volatility.

He uses a hypothetical scenario where an investor held a portfolio of Nifty 50 stocks, all of which eventually failed except for Walmart. Even if Walmart was the only survivor, the returns would still be exceptional, demonstrating that the market returns of an index often come from a very small number of companies.

Pabrai underlines the core lesson: the most crucial aspect of investing is not to sell these great businesses, as their long-term growth powers overall portfolio performance. "the nature of capitalism is that the market returns of an index are actually coming from very few companies and the most important thing is not to sell those companies."

Pabrai emphasizes the importance of evaluating a company's 'moat,' which refers to its sustainable competitive advantage. He suggests investors ask critical questions about the long-term durability of a business model, using SK Hynix as an example.

He specifically questions the future of memory businesses, asking, "important thing to ask yourself is what is the mode of SKHEX? So 10 years from now, are there still three players in the memory business?" This highlights the need to focus on whether the business model will remain relevant and defensible over time. Pabrai advises against exiting an investment until there is clear and compelling evidence of a permanent decline in the company's competitive advantage.

For beginner retail investors, Mohnish Pabrai offers straightforward advice: start by investing in Berkshire Hathaway. He believes this provides a solid foundation as it is managed by experienced investors and holds a diversified portfolio of high-quality businesses.

Pabrai also recommends that investors look for businesses whose products they personally use. By building a list of consumed products and subsequently studying the companies behind them, retail investors can leverage their everyday experiences to gain insight.

His proposed strategy involves allocating 90% of the investment to Berkshire Hathaway and the remaining 10% to carefully selected consumer picks derived from personal research and consumption habits. "What they need to do is buy Berkshire Hathaway."

The interviewer points out that retail investors, by virtue of being consumers, can develop a 'circle of competency' in identifying market shifts. This unique advantage stems from their daily interactions with products and services.

For instance, a retail investor might notice a significant improvement in a product, such as a 10% increase in Burger King sales in a single quarter following product changes. These firsthand observations allow retail investors to identify brand improvements or declines through personal usage even before the broader market or institutional investors catch on, giving them a potential edge.

Mohnish Pabrai recounts Warren Buffett's iconic 1964 investment in American Express, which occurred despite the company facing a significant lending loss. Buffett, known for his deep understanding of business moats, approached this investment with a unique method to verify the company's brand strength.

Instead of relying solely on financial reports, Buffett personally visited various fine dining restaurants to observe whether they were still willing to accept American Express cards. He found that "none of the restaurants had any hesitation zero," indicating that the brand's reputation and customer loyalty remained intact despite the financial setback.

This hands-on due diligence underscored Buffett's confidence in American Express's enduring brand moat, leading him to invest a substantial 40% of his fund into the company. His decision was driven by the fundamental strength of the brand, rather than being swayed by temporary price drops or negative news.

Mohnish Pabrai expresses admiration for Chinese investor Duan Yongping, who founded successful smartphone brands Oppo and Vivo. Yongping's investment strategy highlights the value of recognizing and investing in superior competitors, even if they operate in the same industry.

Pabrai notes that Yongping holds a substantial position in Apple, explaining Yongping's rationale: "We can never replicate what Apple can do on the software side, you know, the the look and feel, the brand. So he said that the smartest thing for me to do is to own them." This demonstrates a strategic decision to own a part of a company that possesses an unreplicable competitive advantage in software and brand.

Mohnish Pabrai identifies his biggest investment mistake as selling high-quality businesses too early, even when they appeared to be overvalued. He admits to previously adhering to a strategy of selling undervalued stocks once they reached what he considered fair value.

He provides a striking example with Ferrari, a business he now believes should never be sold. Pabrai recalls selling a mere 1% of Ferrari, an investment that, had he held onto it, would be worth approximately $1 billion today. This illustrates the massive opportunity cost of parting with exceptional companies.

Pabrai emphasizes that truly great businesses, like Ferrari, which recently sold the first production run of its electric car for $40 million, possess unique characteristics that warrant holding them indefinitely, even if their market valuation seems high. "Ferrari is a business that should never be sold. Recently, they sold the first production run of their electric car for $40 million. Car number one was sold for $40 million."

Mohnish Pabrai reveals that it took him more than 20 years to fully grasp the critical importance of holding onto exceptional businesses. This realization came after decades of experience and observing the long-term performance of companies he had previously sold.

He states, "Great businesses are very rare and they should be held even if they appear overvalued. Took me more than 20 years to learn." Pabrai hopes that by sharing his hard-won lesson, he can help viewers avoid similar long-term investment mistakes. The understanding that 'great businesses are very rare' is a crucial insight for achieving substantial long-term returns.